Hedge Funds Bought $1.7tn of Treasuries, and 60% of It Is One Arbitrage

Hedge Funds Bought $1.7tn of Treasuries, and 60% of It Is One Arbitrage

Between 2022 and 2025 US hedge funds added $1.7 trillion of Treasuries, the second largest increase of any sector behind non-bank financials. Over the same stretch the Federal Reserve shed about $1.9 trillion.

■ This money did not come to hold

A Federal Reserve study published in June broke the positions apart and found roughly 60% of them sit in the cash-futures basis trade: buy the cash Treasury, short the matching futures contract, earn the gap between them, and fund almost the entire cash leg in the overnight repo market. That is leveraged arbitrage built on short-term borrowing, not an investor deciding to own bonds. The Office of Financial Research puts hedge funds at about 7% of the marketable Treasury market today, up from 4% in 2021.

Positions like these are calm most of the time and head for the exit together when they are not, as they did in March 2020. The Securities and Exchange Commission now requires eligible cash Treasury trades to be centrally cleared by the end of 2026 and repo trades by the middle of 2027, which puts a seatbelt on the role these funds have taken.

Source: Bloomberg, the Federal Reserve and the US Office of Financial Research (Image: @GlobalMktObserv)